While you’re chasing invoices and willing your clients to settle up before your rent is due, putting funds aside for your retirement may seem like a distant pipe dream. But start putting a bit of your income into a pension now, and your 70-year old samba-dancing-Caipirinha-drinking-self will be very grateful. Find out what the options are when you’re self-employed.
- In this article
- Cultivate a good pension saving habit
- What is a pension and how does it work?
- How do you start setting up a pension?
- Pension options for the self-employed
- Personal pensions
- Self-Invested Personal Pension – SIPP
- Stakeholder pensions
- National Employment Savings Trust (NEST) explained
- Lifetime ISAs (LISAs)
- Last but not least...
Cultivate a good pension saving habit
Saving into a pension is more challenging for the self-employed – it requires impetus to research and start your pension, then it requires discipline. You see money land in your bank account and have to proactively siphon it off into silos for pension, tax, rent and other bills. You don’t get to welcome any employer pension contributions, and a fluctuating income can make a good pension habit that bit harder to nail.
Whilst around 50% of PAYE employees are paying into a pension, this figure drops to 18% with the self-employed. Nobody is breathing down your neck to start a pension: it’s entirely your responsibility.
What is a pension and how does it work?
A pension is a saving plan for your retirement, open to UK residents under 75 years. When you add money, you get a top up from the government, making it one of the most bountiful tax benefits available. So if you pay in £100, the government effectively adds £25 to your pension.
The government offers a state pension based on your National Insurance (NI) record. For the current tax year (2019-20) this is £168.60 per week. If you’re self-employed, you’re entitled to the State Pension in the same way as anyone else.
This is nothing to be sniffed at, but won’t keep you in suncream and sangria when you’re trying to perma-tan yourself on the Costa del Sol in your 70s. If you want your golden years to shine, you need to get a pension plan in place.
For every contribution you make to your chosen pension, the government tops it up with an extra 20%, beefing up the amount of money you’ve saved (known as basic-rate tax relief). Your pension provider neatly claims this on your behalf and adds it to your pension.
Good personal pension plans give you low-cost access to professional investment managers who invest your money in a range of assets, a logical way of managing risk.
You have choices in how to manage your pension savings when you reach retirement, including taking up to 25% as a lump sum without paying tax.
You should discuss your personal needs and circumstances with an independent financial adviser and they will advise how you can best plan for your retirement.
What is the annual pension allowance?
You can save as much as you like towards your pension each year, but there’s a limit on the amount that will get tax relief – referred to as an annual allowance. For 2019-20 this is set at £40,000 (or 100% of your earnings for the year if less). If you go over £40,000, you won’t receive any tax relief on further pension savings.
It’s possible to carry over unused annual allowance from the previous three years.
How much can I save in my pension in total?
Known as your lifetime allowance for pension – this is the total amount you can have in all your pensions together over your life and is currently set at a tax-free £1.055 million.
How much should I put in?
How much you should put in your pension depends on your personal circumstances. There are different metrics for calculating a suitable sum to see you through your later years. One of the simpler suggestions is to save 15% of your pre-tax income.
A different illustration is: if you plan to retire at a budding 65 years, save an annual percentage of your salary that’s equal to at least half your age when you start saving. For example, if you diligently started your pension at 24 years, 12% of your salary should do it. If you start at a more tardy 40 years, you’d be looking at saving 20% of your salary into your pension.
If your income see-saws, work out what sum you should save per annum and endeavour to reach it through paying ad hoc amounts when your invoices are settled. You’ll need a flexible pension plan to reflect this, which we will discuss.
How to save when you’re just getting by
It’s a different kettle of fish when you’re self-employed. Employees on PAYE (even though they don’t get to enjoy Skype calls in a classic half-shirt-half-pyjama-look) have all their monthly deductibles of tax and pension contributions funnelled off automatically. They don’t miss that cash as it never hits their account.
The self-employed need to be more diligent and proactive, as you probably are with your tax. When your invoices are settled, divert a set percentage sum to your pension. If you’re busy at the time, at least put it by in a separate pot in your account so you can pay it into your pension next time you sit down to do your admin.
See it as an investment in your own future. You may have to stay in a couple of nights more a month or lose a few luxuries but you should feel good about getting on top of your affairs.
How do you start setting up a pension?
Firstly, take a few moments and cast your memory back to recall if you might have any historic workplace pensions if you were in gainful employment at any point. If you’re not sure or can’t remember where your pension may reside now, use the handy Government’s Pension Tracing Service to locate any mislaid plans.
Transferring a pension
If you do luck out and unearth a pension, look at its performance and related fees. You may want to combine it into a new plan for easier management. Firstly, make sure you won’t lose valuable guarantees, query any significant exit or transfer charges and signal the move to your new pension provider – who should take care of all of it. Easy.
Pension options for the self-employed
The best pension for you depends on your individual circumstances. If your income fluctuates, find a plan and provider who will let you make ad-hoc contributions as and when you want.
We recommend you speak to an independent pension advisor to get a comprehensive explanation, and use our handy breakdown below to inform yourself of the basics of pension schemes. Your choices are:
- Ordinary personal pension
- SIPP (self-invested personal pension)
- Stakeholder pension
- NEST (National Employment Savings Trust)
- LISAs (Lifetime ISAs)
This is the most common pension plan: you pay your money in and choose the level of risk you want to take and where you want your contributions to be invested from a range of funds offered by the provider. They can offer between a dozen and several hundred funds.
Your money goes into a group pool for your risk level and the group funds spread risk across multiple markets that could include real estate, infrastructure, insurance, gold, energy or other commodities. So if one area takes a hit, but another steps up, your losses are mollified.
As a guiding principle – if you’re starting your pension early you can carry a higher level of risk. Later on you should seek more stability in your pension investment fund. Your provider will probably take this into account and shift your risk level automatically ten years before your declared retirement date. Handy. They will also claim your tax relief on your behalf and add it to your pension savings.
How much you get back depends on a number of factors: how much is paid in, how well your savings perform and the level of charges you pay.
Pros of personal pensions
It’s a fairly safe option with minimal intervention required by the saver.
Even a modest monthly amount saved into a pension from now will amass into a decent sum for your retirement thanks to compound interest – in other words, interest on your interest. What’s not to like about that?
Cons of personal pensions
Charges can be hefty, particularly on older plans. Given that your pension will be invested into stocks and shares, there will be a risk involved so the returns on a personal pension will vary.
You can start withdrawing your personal pension at a reasonable 55 years but some find this restrictive, preferring to rely on ISA investments which gives access to your money whenever you want.
Self-Invested Personal Pension – SIPP
A SIPP is a type of pension that gives you the freedom to choose all your own investments in stocks and shares, investment trusts and more. If you play the stock market, this might be an attractive option. The principle here is to diversify your portfolio to reduce your risk.
There’s a large degree of responsibility and risk that comes with the freedom and flexibility of a SIPP – you’ll need to be confident making your own investment decisions.
SIPPs work much the same way as other personal pensions: you add money and the government pays in an extra 20% in basic-rate tax relief. If you pay a higher rate of tax, you should be able to claim back even more via your tax return.
Being a flexible option, you can change your investments as and when you like, with full visibility of performance. You’re free to start withdrawing up to 25% of your pot tax-free from your SIPP from 55 years. The balance you will pay income tax on.
Pros of SIPPs
It’s a dynamic option – the broad investment choices and opportunities can make a significant difference to your overall savings.
It can also be beneficial if you’re self-employed and happen to own a commercial property and want to take advantage of valuable tax relief. A few of the killer advantages include: tax relief on contributions paid into your SIPP; exemption from capital gains tax when the property is sold; exemption from income tax on any rental payments, and upon a member’s death there normally won’t be an inheritance tax liability because the property is an asset of a SIPP scheme.
Cons of SIPPs
It’s a more expensive choice – you’ll need the funds to carry the costs of a SIPP. And if your initial investment is fairly small, your potential returns could be consumed by charges. Do your research and compare the fees of the different SIPP platforms – focus on the drawdown (withdrawing money out of your pension to live on in retirement) and the charges you pay. If your SIPP is to be funding 20 or even 30 years of retirement, high charges will take a big chunk out of your savings.
You need time, insight and confidence to make informed investment decisions. It carries the most risk – but with that can bring the best returns.
If you don’t have significant savings, aren’t remotely interested or skilled in the stock market, or have no other retirement plan in place, a SIPP would unlikely be for you. It can leave you open to losing your entire retirement fund which would be somewhat... disappointing.
Stakeholder pensions are a form of defined contribution personal pension. They have low and flexible minimum contributions, capped charges and a default investment strategy if you don't want too much choice, which can be dizzying. There are no exit charges, and the minimum contribution is £20 per month.
You can use your entire pension to buy an annuity (a retirement income) – providing ongoing revenue; withdraw the entire fund as a cash lump sum (again, 25% will be tax-free); or a combination – part cash, part annuity. Benefits can be taken from 55 years.
If you’re not a high-risk roller excited by the thrills of a SIPP, and your pension contributions will be fairly low, a stakeholder pension presents a no frills, basic option.
Pros of stakeholder pensions
Stakeholder plans are flexible with no penalties for moving them, or stopping and starting contributions, or retiring early. The fund will grow with no liability to tax on capital gains.
Low charges make this an economical way to create a pension pot. Fees are capped, investments are low-risk and you can make variable and low contributions each month. This will resonate with self-employed individuals who have to navigate large fluctuations in their income – your contributions can ebb and flow in return.
Cons of stakeholder pensions
Stakeholder pension plans typically have a more limited fund choice and restricted investment solutions compared to personal pension plans or SIPPs.
National Employment Savings Trust (NEST) explained
NEST may be familiar to those who have been an employee on PAYE. Its NEST a trust run for the benefit of its members. No shareholders or owners. But you can also join Nest if you are self-employed, the sole director of a company that doesn’t employ anyone else and usually work in the UK.
To establish an account you’ll need to set up a £10 minimum contribution and top-up as and when you like.
Pros of NEST
Despite the initial charge it's still one of the cheaper options and accepts low monthly contributions. The fees are 1.8% contribution charge, and 0.3% annual management charge.
You can transfer in (0.3% standard AMC charge on your transfer value) and out (free) of NEST.
Cons of NEST
Returns are pretty low in comparison to other pension options.
Things can get complicated if you take on any employees as new employer pension duties will apply.
Lifetime ISAs (LISAs)
LISA is a relative new kid on the block, overwriting the government’s Help to Buy ISA scheme. It also presents an option for early-bird savers aged between 18 – 39 years to pay in up to £4,000 per year to save towards their retirement. You can keep paying into the account until 50 years before it goes on ‘lockdown’ to gather interest for 10 years. You can access your savings in a time of dire need, but it’d incur a hefty 25% withdrawal fee.
Pros of LISAs
When you turn 60 years you can choose to take the money out with the 25% government boost added on. A LISA could be a welcome guest at your milestone birthday – if you want to withdraw a £100,000 lump sum to fund your toga party on a Carribean island, you may.
Unlike a pension, your savings are entirely tax-free. A pension only allows 25% tax-free – the balance is usually paid out at the basic tax rate.
Cons of LISAs
There aren’t many LISA providers, but between them, they do offer choice – some let you open an account with just £1, while others require £100 and up to £250. Minimum regular investments usually start around £25 a month.
The 1-2% interest on a cash LISA is rather limited. If you’re feeling more ambitious or are in it for the long term, an Equities LISA allows you to invest your money in stocks and shares to try and get a better return.
Last but not least...
Check your pension every so often to see how your investments are performing and how your savings are building. It’ll also keep you motivated to keep saving, or intervene if you don’t feel your nest egg is achieving what it should.
And the very, very last pension point to mention...what happens when you die?
Put the question to your provider. Stipulations differ according to your pension plan, and rules and regulations around inheritance and income tax vary depending on which side of 75 years you die. If you do die before, your pension can usually be passed on to your beneficiaries as a lump sum without inheritance tax deductions. At least someone can enjoy the fruits of your labour...and they’ll be thinking of you.
As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.
About the author
Tess O’Leary is a freelance copywriter and cultural strategist, who is also in the midst of launching a couple of new products - Ore and Hexe. She studied architecture, which was painfully slow, so upped the tempo by migrating to digital design, romping through marketing and communications to reach a happy place in writing, research and product development.Read more of Tess's writing